Portfolio Allocations Using Fundamental Ratios: Are Profitability Measures Effective in Selecting Firms and Sectors?

Posted: 22 May 2019

See all articles by J. Christopher Hughen

J. Christopher Hughen

University of Denver - Daniels College of Business

Jack Strauss

University of Denver - Reiman School of Finance; University of Denver

Date Written: May 3, 2016

Abstract

Our study assesses the performance of portfolios formed using out-of-sample sector forecasts and past firm fundamental ratios. Portfolio allocations based on profitability measures - gross profit, operating pro fit, and EBITDA - generate performance substantially better than the benchmark. Long/short portfolio allocations using these fundamentals possess alphas over 14% and increase Sharpe ratios by over 60%. A composite variable provides the highest payoff for firm allocations, while EBITDA produces the most profitable out-of-sample sector allocations. Profitability metrics are superior indicators of sustainable economic performance because these ratios are more strongly linked to future returns and cash flows than net income.

Keywords: Portfolio Allocation, Sector, Fundamentals, Gross Profit, Operating Profit

JEL Classification: G11, G12, G17

Suggested Citation

Hughen, John Christopher and Strauss, Jack, Portfolio Allocations Using Fundamental Ratios: Are Profitability Measures Effective in Selecting Firms and Sectors? (May 3, 2016). The Journal of Portfolio Management 43, 87-101, 2016. Available at SSRN: https://ssrn.com/abstract=2699948 or http://dx.doi.org/10.2139/ssrn.2699948

John Christopher Hughen (Contact Author)

University of Denver - Daniels College of Business ( email )

2101 S. University Blvd
Denver, CO 80208-8951
United States
303-803-6171 (Phone)

HOME PAGE: http://www.hughen.com

Jack Strauss

University of Denver - Reiman School of Finance ( email )

2101 S. University Blvd
Denver, CO COLORADO 80126
United States
314 602 7265 (Phone)

University of Denver ( email )

2201 S. Gaylord St
Denver, CO 80208-2685
United States

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